The Milltrust Emerging Market team addresses the key investor concerns around the asset class.
Clearly, there is a lot to worry about from growth to geopolitics, and from inflation to monetary policy. In the commentary below, we address some of these key concerns and offer reasons why investors should not despair.
Is the price of oil now so high as to represent a headwind to growth?
No. If you look at the consumption of oil in the context of spending on oil as a % of GDP for the Emerging Market countries, currently around 4%, oil is far from being expensive and therefore not a structural headwind. We have just come off a period of extraordinary cheap oil where spending on oil was a very tiny part of Emerging Market countries GDP and we are now back to something close to the 30 year long term average. Therefore, at $110 a barrel, oil prices are not representing a significant expense on Emerging Market consumption. Even China and India, who are both net energy importers, have been able to mitigate some of the impact of higher prices on their terms of trade by buying discounted Russian oil.
Has China become uninvestible?
No. Out of the three main headwinds weighing on Chinese markets, we believe that two of them have now been alleviated leaving only China’s zero COVID policy as the key risk remaining. The two headwinds that we believe have diminished include (1) China’s regulatory crackdown, which has mainly been focused on the internet platform companies, and (2) the threat of delisting Chinese stocks in the US. With regards to the former, the Chinese authorities came out with a very strong statement in March addressing the Chinese regulators to stop issuing random new regulatory probes and fines on these companies and instead focus on enforcing the rules that they have already announced. The message was one of regaining stability. With regards to the latter, the Chinese have backed away from their hard-line stance in response to the SEC audit trail request and allowed some flexibility in how the Chinese companies can respond which has eased this problematic issue.
These marco threats have clearly had a negative impact on markets and it would be easy to assume that fundamentals must have also deteriorated. However, the earnings results released in March tell a very different story; Chinese stocks have been showing pretty decent earnings growth since Q4 2021. This is consistent with the recently-released first quarter growth numbers of 4.4% YOY growth which substantially exceeded expectations given the sharp lockdown in China. Lockdown clearly had an impact on the service sector but did not have as bad an effect on the manufacturing sector. China has set their growth target to 5.5% and we have seen plenty of monetary stimulus, fiscal policy easing, rate cuts and a big pick up in fixed asset investment and infrastructure spending which puts China on track for a stimulus driven growth through the rest of the year.
Concluding Remarks
All of these headwinds have clearly created a difficult ‘macro cocktail’ for investors to digest over the short term. We also saw the inflation-adjusted rate on the 10-year US Treasuries briefly rise above zero for the first time in two years. Higher US real yields provides additional potential challenges for Emerging Markets, although the optimist would argue that positive real rates would in fact bring us closer to peak Fed hawkishness, which is the ultimate requirement for risk appetite to stage a meaningful comeback.
While sentiment is difficult to time and China’s zero COVID policy difficult to comprehend, the main takeaway here is that strong businesses are continuing to grow their bottom line and those are the businesses investors should be focused on. For fundamental-focused equity investors, it always comes down to simply being invested as 90% of stock moves, happen in only 5% of the time and when those moves happen is impossible to predict.
By Eric Anderson, Head of Emerging Markets, Milltrust International LLP
